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A Rocky Road Ahead for Ford and GM

On Aug. 17, Standard & Poor's placed its ratings on Ford Motor Co. (Ford) and its related entities, and General Motors Corp. (GM) and its related entities on CreditWatch with negative implications. Included in the CreditWatch placement are the finance units of both companies, Ford Motor Credit Co. and General Motors Acceptance Corp.

The ratings on Ford's subsidiary, Hertz Corp., remain on CreditWatch, however the CreditWatch implications were revised.

The CreditWatch placements reflect Standard & Poor's heightened concern about the long-range profit potential of these two automakers. To date this year, automotive demand in their core North American market has been far stronger than previously assumed. Yet, price competition has intensified dramatically, and both companies have experienced substantial market share erosion. At the same time, their efforts to reduce costs have been inadequate to offset these adverse developments. Hence, their profitability in North America has deteriorated significantly -- boding ill for their financial performance if a cyclically weaker market environment were to unfold. Moreover, given the ongoing proliferation of competing product entries, both companies face the prospect of diminished earnings contributions from their sport utility vehicles and pickup trucks, which have accounted for a disproportionately large share of overall profits.

Over the past year, Ford's results have been marred by its costly tire recall, and various quality and production problems. Ford has indicated that it is contemplating extensive restructuring actions in North America beyond the manpower reduction program that was announced today.

General Motors has made significant gains in labor productivity in recent years, and has recently enjoyed a measure of success with certain important new sport utilities and pickups. However, GM continues to be burdened by an overly complex brand structure and product mix, and by a legacy of lackluster styling.

Both Ford and GM are diversified geographically, however, their non-North American automotive operations are presently not meaningful contributors to earnings or cash flow, and this is likely to remain the case for the next few years. Cost cutting and a renewal of product offerings have benefited Ford's European operations, but these remain only modestly profitable. GM's European operations have generated heavy losses since mid-2000, and management has indicated that an extensive restructuring plan is currently being developed. The economic environment in Latin America is deteriorating, and this will likely preclude further recovery of the important Brazilian market. Moreover, certain underperforming affiliates-Mazda Motor Corp. (33.4% owned by Ford) and Isuzu Motors Ltd. (49% owned by GM) -- are also having a negative impact on results.

Weaker operating cash flow, coupled with acquisitions and distributions to shareholders of the past two years, have resulted in a significant reduction in the liquidity positions of Ford and GM. While Ford's remaining cash position is significantly larger than GM's, GM may be able monetize its approximately 30% ownership interest in Hughes Electronics Corp., which it is currently in negotiations to sell. Still, overall financial flexibility remains above average. If their commercial paper ratings were downgraded to 'A-2' from 'A-1', which would likely occur along with any lowering of their long-term ratings, Standard & Poor's expects that Ford and GM would be able to make any necessary adjustments to their funding approaches. Indeed, both companies have already acted this year to reduce their reliance on commercial paper borrowings.

As part of its reviews, Standard & Poor's intends to meet with the managements of both companies, to reassess their strategies for coping with present business challenges, and for maintaining financial flexibility. Standard & Poor's expects to resolve these reviews by late October. From Standard & Poor's CreditWire

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